Elections and the Economy: Fear of Flight

Political
risk has historically been the focus for domestic and foreign investors in the
year preceding elections in Nigeria. It is often said to contribute to capital
flight, instability of the local currency and a distraction from economic
reforms. Systematic to most election cycles is some level of political
instability amongst and between rival parties and in some cases violence,
increased government spending skewed towards campaigning and winning the popular
vote, often at the expense of capital expenditure and economic progression.

However,
what is unclear is whether these factors alone account for the volatilities in
foreign currency and capital markets in the run up to elections or whether the
movement in Brent oil prices, Monetary Policy decisions in developed economies
and other exogenous factors play a role. To better understand the potential
implications of electioneering and political risk on the economy as a whole we
look at the last five elections (1999, 2003, 2007, 2011 and 2015), specifically
the 12month period either side of the elections.

In
diagnosing political risk, we analyzed the political climate and how close the
elections were in those years while scrutinizing changes in the nation’s
foreign exchange reserves; capital importation (as a gauge of foreign investor
participation); headline Inflation, benchmark interest; foreign exchange rate
(both Inter-bank & Parallel market); yields in the fixed income market
(91-day T-bill); and movement in the equities market. In addition to this, we
incorporated movements in global Brent oil prices and the U.S. Federal Reserve
rate over the same period, given the importance to the Nigerian economy and
foreign investor participation.

1999 Elections - The First Democratic Election since Military Rule

The
1999 elections between Olusegun Obasanjo (PDP) and Olu Falae (Alliance for
Democracy (AD) – a coalition between AD & All People's Party (APP)) was met
with skepticism by both local and international stakeholders given that it was
the first democratic election since the military took over the helms of affairs
of the governments in 1983.

Nonetheless,
it was a contest between two candidates from the South Western part of the
country, which many people perceived to be the case of soothing the pain of the
Western part of the country following the annulled June 12, 1993 General
election. Since it was an election between two people from the same tribe, the
political risk may have been conceived to be less severe.

Obasanjo
eventually won the election. On the economic front, while the U.S. Fed rate
trended down to 4.75% in the midst of the Long Term Capital Management Hedge
Fund crisis, oil prices were heading north, from a low of c.US$10/ barrel to
US$26/barrel over the period.

However,
oil production levels were falling rapidly, which may have contributed to
foreign currency reserves sinking as low as US$4.7billion and the local
currency weakening in both the interbank and parallel market by 20-24% to
N105/USD. The decline in oil revenues, reserves and depreciation in the local
currency may have contributed to the equities market falling by as much as 18%
over the period.

2003 Elections – Elevated political risk

Unlike 1999, political risk could be said to be high
during the 2003 elections, which was won by the incumbent President Obasanjo.
The run up to voting was marred by violence, with several top politicians
murdered; prominent among them was the assassination of key leader of the AD,
Chief Bola Ige who was the serving Federal

Attorney General and Minister of Justice.

This generated a lot of tension especially in the
Western part of the country. On the global front, the U.S. Fed cut interest
rates from 1.75% to as low as 1% as the U.S. economy struggled with the
aftermath of the dot com bubble. It would also appear as though the Central
Bank of Nigeria’s (CBN) decision to reduce interest rate were in line with the
U.S. Fed’s timing.

Also,
Brent oil prices gained as much as 52% over the period to US$30/b while
domestic oil production inched up from lows of about 2mbpd to 2.5mbpd. On a
negative note, foreign currency reserves fell by 27% to US$7.5billion with the
Naira shedding 19% against the USD to N140/USD at the interbank market.

With
this said, it would appear as though investors were bullish in the equities
market, which may not be unconnected with the moderations in interest rates by
both local and foreign central banks as well as improved oil revenues. As such,
we believe the decline in reserves could have been the result of election
spending as the macro economic conditions appeared strong. The sudden rise in
headline inflation to a high of 11% in January 2003, from 5% in October 2002,
and the steep rise in money supply, further supports this ideology.

2007 Elections – The Third Term Agenda

Political
risk was also high during the 2007 elections with President Obasanjo attempting
to run for a third term, which generated a lot of conflict especially from the
National Assembly with allegations of bribery and corruption reported during
the period. The President’s third term agenda also led to a personality clash
with the then Vice President, Alhaji Atiku Abubakar, which further added to the
political risks as elections drew closer. It is also worthy of note that the
eventual President elect, Alhaji Umaru Musa Yaradua confirmed that the April
elections had flaws and shortcomings.

In
the U.S., the Fed gradually began moderating interest rates with GDP growth
slowing as the credit crisis loomed. The CBN followed suit, reducing its own
benchmark interest rate as headline inflation slowed. This, as well as high oil
prices (up 55%) supported the Nigerian economy. Although oil production levels
were volatile, foreign exchange reserves jumped 82% to US$52billion, which
could have aided the appreciation of the Naira at the parallel market by as
much as 17% to N122/USD. Furthermore, the change in money supply was fairly
stable as inflation trended south.

Contrary
to this, major economic indicators were positive while capital importation
dipped significantly, falling by US$560million to a year low of US$220million
in the month preceding the 2007 elections. However, as pointed out the equities
market was very bullish, which was most likely due to the margin loans that
fueled local investor participation.

2011 Elections – North
vs South

Following the death of President Yar’Adua in 2010, the
2011 elections were mired by controversy within the ruling PDP as to whether a
Northerner or Southerner should be allowed to contest the Presidential
election. This led to agitations from the North on the belief that they were
still supposed to be in power as the late President Yar’Adua did not finish his
tenure.

Consequently,
violence erupted in the region with the Human Rights Watch stating about 140
people were killed in political violence. This increased violence and political
risk may have sparked capital flight as both the equities and treasury markets
were relatively bearish. It may also have been partly induced by CBN’s hawkish
stance and possible capital flight as capital importation slowed during the
period.

Despite
oil prices rising to US$117/barrel and oil production above 2.4million barrel,
foreign currency reserves fell by 23% to US32.6billion. However, inflation
moderated, which could signal that the drain in reserves may not have been the
result of election spending but more in defence of the Naira, which lost 8% to
N165/USD.

2015 Elections – Peaceful Transition

The
2015 elections were centered on increasing insecurity (Boko Haram) and economic
strains. Buhari and the All Progressives Congress (APC) were viewed as more
equipped to fight insecurity and corruption against the incumbent President
Jonathan. The elections and the transition of power were both stable and
peaceful. Although political risk was relatively low with no threat from
external environment as the U.S. Fed maintained interest rates, the Nigeria
economy was negatively impacted by falling Brent oil prices (down about 50%)
despite oil production rising to 2.5million barrels per day.

Lower
oil revenues, on the back of the decline in oil prices, government spending and
capital outflows led to the slide in foreign currency reserves to below
US$30billion and consequently the depreciation of the Naira to N197/USD at the
interbank market. This and the uncertainty regarding the outcome of the
elections may have contributed to the bearish sentiment in the equities market.

Our Outlook for key
parameters examined in past elections

·US Fed is likely to remain hawkish while there is
potential for CBN to shift to an accommodative monetary policy

·Oil price to remain high (above US$70/barrel)

·Oil production fairly stable at 2mbpd on stability in
the Niger Delta

What does this say about
the potential impact of electioneering on the capital and foreign exchange
markets?

From
our analysis of the last four presidential elections, there appears to be a
slight correlation between political risk and capital flight. However, the
extent of this is dependent on the intensity of the elections and conflicts
within the country. It is also worthy to note that exogenous factors such as
decline in oil prices tend to exaggerate the capital flight, decline in foreign
currency reserves and the slowdown in economic activities.

While
the political tension has gradually been escalating in the run up to the 2019
elections, we expect this to intensify as parties step up their respective
campaigns and spending, particularly as we approach and move past the primaries
in October 2018. Although there is a chance for an accelerated budget
implementation particularly short term projects and recurrent expenditure, we
expect electioneering to detract from much needed economic reforms to spur
growth while we should see headline inflation trend upwards.

2019 Election Timetable

Furthermore,
we are concerned about the escalating violence in the North between Farmers and
Herdsmen, which could negatively impact food supply and inflation, as well as
spreading to other parts of the nation. Although calm, the potential for a
resurgence of unrest in the Niger Delta remains, which is key to oil production
and revenues; and handling of Boko Haram insurgence could be even more delicate
as electioneering intensifies.

However,
what is clear is that we are already seeing a level of capital flight but this
has largely been systematic to most emerging market economies as a result of
‘risk off’ sentiment by foreign investors due to concerns on geopolitical
tensions, U.S. Fed’s rate hikes and trade war.

This
contributed to the lackluster performance in the domestic equities and fixed
income markets in Q2 2018 and Q3 2018 despite Brent oil prices remaining high,
oil production levels improving, although volatile, and the nation’s foreign
exchange reserves remaining above US$45billion.

Even
though the outlook for key economic indicators appears positive, we could see
further capital outflows in H2 2018, with an estimated US$9billion of local
treasury bills held by foreign investors at the end of August 2018, due to
uncertainty on the outcome of the elections.

The
level of outflows could be amplified by increased violence in the North as well
as an escalation of trade tensions in the global space. Nonetheless, we expect
that the accretion to reserves (+50% y/y) over the last 12months should aid the
Central Bank of Nigeria in the defence and stability of the Naira amidst
capital outflows as witnessed in recent months.